Asia Pac J Manag (2011) 28:139155

DOI 10.1007/s10490-010-9226-4

Effects of governance on investment decisions

and perceptions of reporting credibility: Investment
experience of Taiwanese individual investors

Ruey-Dang Chang & Jo-Ting Wei

Published online: 27 August 2010

# Springer Science+Business Media, LLC 2010

Abstract This paper examines the effects of governance strength on individual

investors investment decisions and their perceptions of the credibility of financial
reporting by Taiwanese companies. It also examines whether the investment
experience of individual investors influences their perceptions and decisions. Our
experimental results show that governance strength enhances the price that
individual investors are willing to pay for stocks, along with the perceived
credibility of firm reporting. Furthermore, the associations are moderated by the
investment experience of individual investors, suggesting that more-experienced
individual investors are better able to incorporate governance strength into their
judgment than less-experienced individual investors. Additionally, investment
experience is positively related to the emphasis that individual investors give to
corporate governance information in making investment decisions.

Keywords Governance . Performance . Individual investors . Investment experience .

Behavioral finance . Taiwan

The authors would like to thank the three editors of this Special Issue (Mike Peng, Steve Globerman, and
Daniel Shapiro), the anonymous reviewers, and Professor P. H. Phan, Professor Y. Jiang, and V. Z. Chen
for their valuable comments on the earlier versions. Also, we thank Taiwan National Science Council for
financial support on attending the Asia Pacific Journal of Management Conference on Managing
Corporate Governance Globally: An Asia Pacific Perspective in Vancouver, Canada, October 2009 (NSC-
98-2922-I-110-055). We are also grateful to Professor D. S. Sharma for his help in article writing and
Professor H. W. Chang for his help in the recruitment for the experimental subjects.
R.-D. Chang
Department of Accounting, National Chung Hsing University, Taichung, Taiwan
e-mail: rchang@dragon.nchu.edu.tw

J.-T. Wei (*)

Department of Business Management, National Sun Yat-sen University, Kaohsiung, Taiwan
e-mail: heartreal@gmail.com
140 R.-D. Chang, J.-T. Wei

In the wake of many recent accounting scandals, there has been increased concern
about corporate governance. Security regulators around the world recognize the
importance of improving corporate governance, and Taiwanese security regulators
are no exception. Indeed, governance reform is crucial to Taiwan. As with most East
Asian countries, Taiwan features firms with controlling family shareholders, weak
legal protection for minority investors, and pyramidal groups. Controlling family
shareholders have incentives to expropriate the wealth of minority individual
investors. In this circumstance, strong corporate boards might, by ratifying and
monitoring important company decisions, limit the power of controlling family
shareholders to extract personal benefits and harm the interests of minority
individual investors (Filatotchev, Lien, & Piesse, 2005; Yeh & Woidtke, 2005).
Compared to American firms, Taiwanese firms have more concentrated ownership
and thus potentially more severe agency problems (Peng & Jiang, 2010; Young,
Peng, Ahlstrom, Bruton, & Jiang, 2008).
In order to protect investors and enhance investors confidence, the Taiwanese
government, in 2002, introduced the best practice principles of corporate governance
for listed companies. Beginning in 2007, Taiwanese public firms had to appoint at
least two independent directors and establish either an audit committee or an audit
supervisor. However, there is no consistent evidence in the literature linking
governance reform to enhanced confidence of individual investors. Moreover, the
majority of governance studies focus on institutional investors in Western countries,
rather than on individual investors (Gillan & Starks, 2007). Accordingly, little is
known about how individual Asian investors perceive corporate governance and
how their perceptions are linked to their investing behavior (Sharma, 2006). This
study provides empirical evidence on these issues in the specific context of Taiwan.
In so doing, it also offers suggestive insights into how corporate governance
standards might affect the perceptions and behavior of individual investors in other
parts of the world.

Theoretical and empirical background

The expanding behavioral finance literature suggests that institutional investors

are better informed and quicker learners than individual investors and, thus,
make better investment decisions (Chiang, Qian, & Sherman, 2010; Field &
Lowry, 2009; Sias & Whidbee, 2010). Field and Lowry (2009) find that
institutional investors outperform individual investors when they invest in IPO
stocks, as institutional investors utilize readily available public information to their
advantage, whereas individual investors misinterpret such information. Chiang and
colleagues (2010) document that institutional investors are better informed bidders
than individual investors. Sias and Whidbee (2010) find that insider demand,
including the demand of officers and directors, is negatively (positively) associated
with demand by institutional investors (individual investors) in the same quarter
and over the previous year.
The behavioral finance literature draws on psychology to help explain why
individual investors tend to do more poorly than institutional investors. In particular,
it examines how cognitive errors and emotions influence the decision-making
Effects of governance on investment decisions and perceptions of reporting credibility 141

processes of individual investors. It finds evidence of herding behavior among

individual investors, as well as overconfidence in their trading abilities. Furthermore,
they rely on reference points to realize gains and to delay the realization of losses.
Heuristics are relied upon to make investment decisions due to limited ability to
process complicated information, and recent investment experience is emphasized in
forming expectations about the future (Barber, Lee, Liu, & Odean, 2008; Barber &
Odean, 2008; Shu, Yeh, Chiu, & Chen, 2005).
Since individual investors make up the greatest proportion of all investors in the
Taiwanese stock market, the weaknesses of individual investors are of particular
relevance to Taiwan. Moreover, there are grounds for concern that individual
investors in Taiwan may be less equipped to make sound investment decisions than
individual investors in Western countries. For example, evidence indicates that
individual Taiwanese investors tend to exhibit behavioral biases such as a reluctance
to realize investment losses more so than individual investors in the United States
(Barber et al., 2008; Shu et al., 2005).
The broad issue addressed in this paper is whether and how governance
attributes of Taiwanese companies affect the perceptions and behavior of
individual Taiwanese investors. Several recent studies for other countries suggest
that individual investors do incorporate governance quality into their investment
decisions (Almer, Gramling, & Kaplan, 2008; Sharma, 2006). In this paper,
governance quality is tied to specific attributes of the board of directors. The
literature on governance and regulation reform suggests specific governance
elements that define a strong board of directors such as independence, expertise,
and the use of subcommittees (Agrawal & Chadha, 2005; McKinsey & Company,
2002). Pearce and Zahra (1991) cluster governance attributes by four types of
boards: caretaker, statutory, proactive, and participative boards. They view the
former two types as weak boards and the latter two types as strong boards. This
paper examines governance strength drawing on the study of Pearce and Zahra
(1991). Specifically, governance strength is defined to be strong or weak, by
measuring governance features of the four board types along two dimensions: the
board and the CEO and the management.1
A number of studies suggest that strong corporate governance can enhance
firm performance, either measured by accounting metrics (such as return on
assets) or by stock price performance (Chu, 2010; Filatotchev et al., 2005;
Gompers, Ishii, & Metrick, 2003). To the extent that individual Taiwanese
investors identify and acknowledge the governance attributes of different
companies, they should incorporate governance attributes into their evaluation of
the likely future performances of those companies. Hence, this paper examines
whether governance strength positively affects investment decisions at the
individual investor level by examining prices that individual Taiwanese investors
are willing to pay for stocks. It also examines whether and how corporate
governance is related to investors perceptions of the firm reporting credibility of
Taiwanese firms.

1
More details on this classification procedure are provided in a later section of this paper.
142 R.-D. Chang, J.-T. Wei

Hypotheses

As noted above, most Taiwanese firms are family-controlled, and controlling family
shareholders are likely to directly participate in management. Controlling family
members often also hold top executive positions such as CEO. Family members
have incentives to adopt investment policies that capture personal benefits when
serving as CEOs (Peng & Jiang, 2010). In addition, family members often dominate
the board. Limited outsider representation on boards is also an essential way for
controlling families to enhance family control (Yeh & Woidtke, 2005). A well-
functioning board is particularly important to limiting the power of controlling
shareholders to expropriate the interests of minority shareholders (Filatotchev et al.,
2005). Past studies have widely examined the relationship between board strength
and firm performance (Peng, 2004) and have provided essential viewpoints from the
agency theory and the resource dependence theory (Phan, 2001; Phan & Yoshikawa,
2000; Young et al., 2008).
The agency theory demonstrates that an independent board of directors can
provide effective oversight of controlling families and prevent them from making
self-serving decisions to extract personal benefits. The resource dependence theory
asserts that independent directors via an abundant network of external contacts
provide essential resources that are more diverse than the resources provided by
controlling families (Filatotchev et al., 2005; Peng, Au, & Wang, 2001). Hence, a
strong board is more likely to restrict entrenched behavior of controlling families,
while a weak board lacks the power to make a firms major decisions and cannot
critically examine managerial decisions. Therefore, individual investors should
perceive their interests to be better protected by a strong board. As a consequence,
they should form more favorable investment decisions about firms characterized by
strong boards and should also perceive firm reporting to be more credible in the case
of those firms. These inferences are formalized in Hypotheses 1a and 1b:

Hypothesis 1a Governance strength is positively related to investment decisions of

individual investors.

Hypothesis 1b Governance strength is positively related to individual investors

credibility perceptions of firm reporting.

To be sure, to the extent that individual investors find it difficult to identify the
strengths or weaknesses of corporate boards, the relationships between governance
strength, investors decisions, and investors perceptions of firm reporting as set out in
Hypotheses 1a and 1b may be empirically weak. In this regard, the behavioral finance
literature documents that the decision-making biases of individual investors tend to
decrease with increased investing experience (Feng & Seasholes, 2005; Nicolosi, Peng,
& Zhu, 2009; Seru, Shumway, & Stoffman, 2010), and that portfolio returns and the
quality of stock trading improve as investors become more experienced (Nicolosi et
al., 2009). More generally, experienced decision-makers are better able to analyze
information than less experienced decision-makers (Dilla & Steinbart, 2005).
In this context, relatively experienced individual investors are more likely to take
the governance strengths of companies into account when making investment
Effects of governance on investment decisions and perceptions of reporting credibility 143

decisions and evaluating the credibility of firm reporting than their less experienced
counterparts. Thus:

Hypothesis 2a The association between governance strength and investment

decisions differs between individual investors with varying levels of investment
experience such that more-experienced individual investors are better able to
incorporate governance strength into their investment decisions than less-
experienced individual investors.

Hypothesis 2b The association between governance strength and the credibility

perceptions of firm reporting differs between individual investors with varying levels
of investment experience such that more-experienced individual investors are better
able to incorporate governance strength into their evaluation of the credibility of firm
reporting than less-experienced individual investors.

The literature on behavioral finance and decision-making indicates that individual

investors regard financial information as easier to interpret and use than information
on corporate governance (Barber & Odean, 2008; Elliott, Hodge, & Jackson, 2008;
Kivets & Simonson, 2000). Indeed, corporate governance information demands
substantial cognitive effort to use effectively. Hence, one would expect the average
individual investor to place more reliance on financial information compared to
corporate governance information when making investment decisions.
As noted above, evidence shows that individual investors learn from their trading
experience and improve their performance over time. The literature also demonstrates
that individual investors, with experience, can incorporate unique information into
performance judgments and hence reduce their reliance on common-measure
information. In short, investment experience should facilitate the use of corporate
governance information in investment decision-making. We therefore expect less-
experienced investors to put more weight on financial information, whereas more-
experienced individual investors will put more equal weight on both types of
information when making investment decisions. This leads to the following hypothesis:

Hypothesis 3 Corporate governance information is as important as financial

information for investment decisions of more-experienced individual investors but
less important than financial information for investment decisions of less-
experienced individual investors.

Methodology

Experimental setting

The experimental setting involves individual investors investment decisions and

their credibility perceptions of firm reporting based on a firms governance strength.
Individual investors were given questionnaires comprising background information,
financial information, and the treatment information (governance strength) about a
fictitious firm EAP in the Liquid Crystal Displays industry. The financial
144 R.-D. Chang, J.-T. Wei

information provided indicated whether the firm was either in good or bad financial
condition, including 2-year comparative simple financial statements (the balance
sheet and income statement), financial indicators for the firm, and industry averages.
Financial indicators included the return on equity ratio (ROE), net equity, the cash
flow ratio, dividends per share, the profit ratio, earnings per share (EPS), and the
return on assets ratio (ROA), which are extensively used in the investment literature
(Deegan & Rankin, 1997; Lawrence & Kercsmar, 1999).
Codes G1, G2, G3, and G4 (B1, B2, B3, and B4) were used as the proxy for
Caretaker, Statutory, Proactive, and Participative boards, respectively, in the scenario
of good (bad) financial condition. The former two types were classified as weak
governance and the latter two types as strong governance. Governance strength is a
dummy variable, which equals 1 if governance strength is strong and equals 0 if
governance strength is weak. We manipulated governance strength by providing
governance features of the four types of boards along two dimensions: the board and
the CEO and the management, as reported in Table 1. These governance
characteristics have been highlighted by security regulators as improving governance

Table 1 The characteristics of corporate governance practices.

Governance strength

Weak Strong

Caretaker Statutory Proactive Participative

(G1 / B1) (G2 / B2) (G3 / B3) (G4 / B4)

Panel A: The board

The percentage of outside directors Less Less More More
The possibility of establishing board Less Less More More
subcommittees
(e.g., audit committee)
The degree to which the board makes Less Less More More
efforts to evaluate the performance
of the CEO and a firm
The degree to which the board devotes Less Less More More
time to a firm
The shareholdings of the board Less Less More More
The expertise and independence of the board Less Less More More
Whether the board has the power to make No No Yes Yes
major firm decisions
Panel B: The CEO and the management
Whether the CEO has the power to make No Yes No Yes
major firm decisions
The shareholdings of the CEO Less More Less More
The possibility for the management to More More Less Less
participate in director selection
The possibility for the management to More More Less Less
selectively present the board information
Effects of governance on investment decisions and perceptions of reporting credibility 145

practices and have been widely examined in governance studies (Agrawal &
Chadha, 2005; McKinsey & Company, 2002).
Schepanski, Tubbs, and Grimlund (1992) note distinct demand effect in the
within-subjects design. In the within-subjects design, each subject is exposed to
multiple treatment conditions. The subjects are easily aware that they are in the
scenario of an experiment, and their behavior may be different from that in the real
world. Taking demand effects into account, this paper adopts a between-subjects
design rather than a within-subjects design. The research design reflects a 42
experimental design with four levels of governance practices and two levels of
financial conditions. Thus, the experiment includes eight experimental groups with
30 people in each group. After the subjects read the financial information about the
firms, we did manipulation checks on financial information and governance
information. Additionally, in order to know whether individual investors were
familiar with corporate governance, we conducted a test of corporate governance
concepts. Then, subjects were required to make investment decisions and evaluate
the credibility of firm reporting. Next, they had to rate the importance of financial
information and corporate governance information for investment decisions. Finally,
they were required to provide demographic data.

Participants and experimental design

The subjects of this experiment were 240 individual investors in Taiwan. Of the
subjects, 63.3% were male, and 36.7% were female. Most worked in Hsinchu
Science Park and Tainan Science Park (63.8%). Others were government and
university administrative personnel (21.7%) or auditors of Big-Four CPA firms
(13.3%). Some of the subjects were also EMBA students (20.8%). About half of
them were in the 3039 age group (49.6%), had a bachelors degree (52.9%), and
had been investing for more than 3 years (48.3%). Their most often used investment
reference source was the Internet. Other sources included recommendations from
their relatives and friends, TV, company insiders, and books and magazines as
reference resources.
In order to avoid possible biased perceptions of the subjects and enhance the
reliability and validity of the questionnaire, pre-testing was administered. The
subjects of pre-testing were 17 people with investment experience, including five
EMBA students, four auditors with Big-Four CPA firms, two professors in the
management department of a university, and six persons working in Hsinchu Science
Park. After some modification of the pre-tested questionnaire, we recruited subjects
who had some individual investment experience. Each subject was randomly
exposed to one of eight scenarios so as to avoid systematic errors and to ensure
replicability. The order of the experimental cases was randomized to avoid potential
order effects.
The majority of experimental studies do not provide any financial incentive to the
subjects due to cost and potential confounding effects (Sharma, 2006), unless the
focus of the experiment is to compare the differential effect between scenarios where
financial incentives are provided or not provided (Sprinkle, 2003). Though we
offered no monetary rewards to our subjects, it is reasonable to expect that they had
incentives to take the experiment seriously. First, the subjects were recruited based
146 R.-D. Chang, J.-T. Wei

on their willingness to participate in the experiment. Second, the questionnaires

included a description of the nature of the study and were enclosed in a sealed
envelope. We also guaranteed anonymity. Moreover, some questionnaires were
administered and filled out by EMBA students in classes; others were distributed to
individuals who were asked to distribute the questionnaires to their colleagues or
friends. We believe that the experimental setting and the distribution process for the
questionnaires motivated the subjects to actively participate in the experiment
without monetary incentives.
Social desirability is one of the most common sources of bias affecting the
validity of survey and experimental research findings. It refers to impression
management: when we know that other people are watching us, we may change our
behavior. Specifically, subjects may respond in a manner to enhance their status.
Although the majority of behavioral accounting research seldom takes this
phenomenon into account (Sharma, 2006; Sprinkle, 2003), we believe that we
mitigated this phenomenon through our experimental design. First, we avoid
adopting highly threatening experimental items. When facing highly threatening
questions, subjects often choose not to respond or respond more frequently with a
socially desirable answer. Second, the subjects answered the items anonymously.
Third, given the focus of this paper, it is unlikely that subjects answered particular
items in order to present themselves in a good light (Darnall, Seol, & Sarkis, 2009;
Nederhof, 1985). Furthermore, our testing showed that the subjects understood and
took the experiment seriously, and our between-subjects design, in which the
subjects were only exposed to one experimental scenario, contributes to experimen-
tal behavior consistent with real-world behavior (Schepanski et al., 1992).

Experimental tasks

Individual investors were required to perform the following tasks: First, they were
asked to decide how much they were willing to pay for the stock of EAP Ltd.
Second, they were required to rate their credibility perceptions of the firms
reporting. The definition of credibility is similar to that of trust: belief that the
actions firms take can produce a positive income for investors (Almer et al., 2008;
Chan, Huang, & Ng, 2008). Subjects were asked to respond to the statement: We
believe the information that the firm discloses using a 7-point Likert scale anchored
by strongly disagree and strongly agree corresponding to 1 and 7. Following
these assessments, they were required to rate the importance of financial information
and corporate governance information for investment decisions using a 7-point
Likert scale with 1 representing the least important and 7 representing the most
important.
In order to test our hypotheses, we include an additional variable investment
experience. Investment experience is a dummy variable assuming the value of 1
if the participant has more investment experience and 0 if the participant has
less investment experience. A more-experienced individual investor is defined as
having more than three years of investment experience, while a less-experienced
individual investor had less than three years of investment experience. Three years of
experience was used as the breakpoint in order to assure a similar sample size for the
two groups.
Effects of governance on investment decisions and perceptions of reporting credibility 147

Analysis and results

Manipulation checks on both financial information and corporate governance

features, as well as the test for corporate governance concepts, adopt a 7-point
Likert scale (ranging from 1 = strongly disagree to 7 = strongly agree). Any subject
misclassifying the firms financial condition or governance strength is considered to
have failed the manipulation check. For example, if subjects receive a case with the
firm in bad financial condition but rate the items describing the firm as indicating
good financial condition, they fail the manipulation check because they misclassified
the firm. Our results find significant differences between good and bad financial
conditions (p < 0.01.) on three items related to financial information. Additionally,
five items among governance features of the four types of boards show significant
differences (p < 0.01). Hence, the manipulations are successful. Moreover, five items
pertaining to the test for corporate governance concepts show no significant
differences between the experimental groups, indicating that the subjects are familiar
with corporate governance.
Table 2 reports the ANOVA results for the effects of governance strength,
investment experience, and interaction on individual investors investment decisions
and their credibility perceptions of firm reporting. Significant main effects on
individual investors investment decisions (F = 16.479; p < 0.01) and their credibility
perceptions of firm reporting (F = 42.490; p < 0.01) are found for governance
strength. Thus, Hypotheses 1a and 1b receive support.
To provide further confirmation of Hypotheses 1a and 1b, we examine the
hypotheses in different financial conditions: good and bad, respectively. Under good
financial condition (see Panel A of Table 3), with respect to Hypothesis 1a, t-tests for
differences in means show that individual investors are willing to pay more for the
stocks of well-governed firms than those of poorly-governed firms (t = 3.483; p <
0.01). As for Hypothesis 1b, t-tests for differences in means indicate that individual
investors credibility perceptions of firm reporting are significantly higher for the
strong governance case compared to the weak governance case (t = 5.480; p < 0.01).
When the scenario changes to bad financial condition (see Panel B of Table 3), the
results also show that governance strength is positively associated with the price that
individual investors are willing to pay for the stocks (t = 4.099; p < 0.01) and their
credibility judgment of firm reporting (t = 6.403; p < 0.01).
We also use the LSD multiple comparison test to examine whether there are
significant differences among the four types of boards: Caretaker, Statutory,
Proactive, and Participative. The first two types are viewed as weak boards and

Table 2 The interaction effects of governance and investment experience on individual investors
investment decisions and their credibility perceptions of firm reporting (N = 240).

Variable Invest (F-values) Credibility (F-values)

Gstrength 16.479*** 42.490***

Invexp 1.935 2.282
Gstrength*Invexp 11.759*** 7.200***

***p < 0.01 (one-tailed).

148 R.-D. Chang, J.-T. Wei

Table 3 The effects of governance on individual investors investment decisions and their credibility
perceptions of firm reporting.

Governance strength Mean (t-values)

Weak Strong

Panel A: Good financial condition (N = 120)

Invest 30.10 40.58 3.483***
Credibility 4.52 5.50 5.480***
Panel B: Bad financial condition (N = 120)
Invest 8.93 16.02 4.099***
Credibility 2.33 3.78 6.403***

***p < 0.01 (one-tailed).

the latter two types are viewed as strong boards. Caretaker boards are characterized
by low board power and low CEO power. Firm executives and their associates
usually dominate the boards, and therefore the boards lack the appropriate mix of
desirable director qualities to serve as credible elements of corporate governance.
Statutory governance boards are characterized by low board power and high CEO
power, which often function as rubber stamps of managerial decisions because of
lack of expertise or interest. The directors are mainly chosen and retained through
the influence of the management. Proactive boards are characterized by high board
power and low CEO power. They are usually composed primarily of outside
directors in order to enhance their independence from management and to increase
the level of expertise among directors. The responsibilities of directors are divided
among established board committees. Participative boards are characterized by high
board power and high CEO power and focus on building and reaching consensus
among directors and the management. Thus, the leadership of the firm is most likely
separated from that of the board with outside directors constituting a majority of
board membership.
Under the good financial condition, the LSD multiple comparison test of
differences among the groups scores shows that Proactive and Participative
boards have higher scores on individual investors investment decisions than
Statutory boards (F = 4.936; p < 0.01). Additionally, significant differences are
found in individual investors credibility perceptions of firm reporting, with
Participative and Proactive leading Caretaker and Statutory boards (F = 11.189; p <
0.01). Under the bad financial condition, results show that Proactive and
Participative boards have higher scores on individual investors investment
decisions than Caretaker boards. Participative boards perform better than Statutory
boards (F = 6.340; p < 0.01). Moreover, compared to Caretaker and Statutory
boards, firms with Proactive and Participative boards get higher individual
investors credibility evaluations on their firms reporting (F = 13.556; p < 0.01).
On the whole, individual investors are willing to pay more for the stocks of firms
with Proactive and Participative boards and less for the stocks of firms with
Caretaker and Statutory boards. In addition, their credibility perceptions of the
Effects of governance on investment decisions and perceptions of reporting credibility 149

reporting of firms with Proactive and Participative boards are higher than the
reporting of firms with Caretaker and Statutory boards.
As for Hypotheses 2a and 2b (see Table 2), ANOVA analyses indicate that there
are interaction effects on individual investors investment decisions (F = 11.759; p <
0.01) and their credibility perceptions of firm reporting (F = 7.200; p < 0.01) between
governance strength and individual investors investment experience. This suggests
that the main effects of governance strength on individual investors investment
decisions and their credibility perceptions of firm reporting are not equivalent across
individual investors with different investment experience. Hence, the relationships
between governance strength and individual investors investment decisions and
their credibility perceptions of firm reporting are moderated by the investment
experience of investors.
Figures 1 and 2 show the nature of the observed interaction. With respect to
Hypothesis 2a, analysis of means shows that individual investors investment
decisions are affected by governance strength when individual investors have
more investment experience (Mweak = 17.17, Mstrong = 33.84; t = 5.138; p < 0.01)
but are not affected by governance strength when individual investors have less
investment experience (Mweak = 21.71, Mstrong = 23.10; t = 0.459; p > 0.1). The line
for more-experienced individual investors is significantly steeper than that for less-
experienced individual investors, showing that more-experienced individual
investors are better able to incorporate governance strength into their investment
decisions than less-experienced individual investors. Thus, Hypothesis 2a is
supported. With respect to Hypothesis 2b, an analysis of means points out that
the reporting of firms with strong governance is judged to be of high credibility
regardless of whether individual investors have more (Mweak = 3.31, Mstrong =
5.05; t = 6.528; p < 0.01) or less investment experience (Mweak = 3.53, Mstrong =
4.26; t = 2.710; p < 0.01). The line for more-experienced individual investors is also
significantly steeper than that for less-experienced individual investors. As a result,
more-experienced individual investors are better able to incorporate governance
strength into their evaluation of the credibility of firm reporting. Therefore,
Hypothesis 2b receives support as well.
We use the paired-samples t-test to examine Hypothesis 3, and test results are
reported in Table 4 (more-experienced individual investors) and Table 5 (less-
experienced individual investors). Panels A and B of Table 4 show that more-
experienced individual investors often put equal weight on financial information and
corporate governance information in their investment evaluation (p > 0.1). Hence,
individual investors with more investment experience take governance strength into
account when making investment evaluations. When firms are in good financial
condition and have weak governance practices, experienced investors put particular
weight on corporate governance information in their investment decision evaluation
(t = 1.771, p < 0.05).
Panels A and B of Table 5 indicate that less-experienced individual investors
often put more weight on financial information than on corporate governance
information when making investment decisions (p < 0.1). However, there is still
some evidence to indicate that less-individual investors perceive value in corporate
governance information when making investment decisions. They rate corporate
governance information as important as financial information in their investment
150 R.-D. Chang, J.-T. Wei

35

More-experienced 33.84

30 Investment experience
Stock price

25
Less-experienced

23.10
21.71
20

17.17
15

Weak Strong
Governance strength
Figure 1 Interaction of governance strength and investment experience on individual investors
investment decisions

5
More-experienced 5.05

Investment experience

4.5
Credibility

4.26

Less-experienced
4

3.53
3.5

3.31

Weak Strong
Governance Strength
Figure 2 Interaction of governance strength and investment experience on individual investors
credibility perception of firm reporting
Effects of governance on investment decisions and perceptions of reporting credibility 151

Table 4 The investment weight of financial information and governance information: More-experienced
individual investors.

Financial information Governance information Mean (t-values)

(A common measure) (A unique measure)

Panel A: Good financial condition (N = 65)

Governance strength
Strong 5.91 5.67 1.543
Weak 5.72 6.03 1.771**
Panel B: Bad financial condition (N = 51)
Governance strength
Strong 5.68 5.52 1.163
Weak 5.50 5.35 0.941

**p < 0.05 (two-tailed).

evaluation when the firm is in good financial condition and adopts weak governance
practices (t = 1.312, p > 0.1).
Additional results on the relationship between financial information and corporate
governance are reported in Tables 4 and 5. The results suggest that the association
between financial information and corporate governance information is complemen-
tary. Specifically, individual investors rely on both financial information and
corporate governance information to make investment decisions. However, how
individual investors use both types of information to make investment decisions
(whether financial information and corporate governance information are perfectly
complementary) depends on their investment experience and their perceptions of
firm risk. Investors are more likely to perceive firm risk when firms are in good
financial condition and adopt poor governance practices. They prefer to invest in
outperforming firms, and poorly-governed firms imply greater financial risk. This
shows that individual investors have some contextual sensitivity to governance

Table 5 The investment weight of financial information and governance information: Less-experienced
individual investors.

Financial information Governance information Mean (t-values)

(A common measure) (A unique measure)

Panel A: Good financial condition (N = 55)

Governance strength
Strong 5.48 4.81 3.766*
Weak 5.33 5.15 1.312
Panel B: Bad financial condition (N = 69)
Governance strength
Strong 5.89 5.37 3.200*
Weak 6.06 5.41 3.126*

*p < 0.01 (one-tailed).

152 R.-D. Chang, J.-T. Wei

strength. That is, corporate governance appears to matter more with respect to
investment decisions for outperforming firms.
As Table 4 indicates, more-experienced individual investors often put the same
weight on financial information and corporate governance information when
making investment decisions. This suggests that more-experienced individual
investors often rely on both types of information to make investment decisions.
In this situation, the relationship between financial information and corporate
governance information is perfectly complementary, suggesting that the ratio
between both types of information (the investment weight) for more-experienced
individual investors will never shift noticeably from 1:1. As noted above,
investors have contextual sensitivity to governance strength. Hence, when more-
experienced individual investors evaluate firms in good financial condition that
adopt weak governance practices, their investment weighting is biased to
corporate governance information. Thus, the relationship between the two types
of information is imperfectly complementary.
As shown in Table 5, less-experienced individual investors often put more weight
on financial information than on corporate governance information in their
investment evaluation. The investment weight of less-experienced individual
investors is often biased toward financial information, suggesting that the
relationship between financial information and corporate governance information is
imperfectly complementary. However, the relationship between both types of
information becomes perfectly complementary when firms are in good financial
condition and adopt weak governance practices. Less-experienced individual
investors pay more attention to outperforming firms with weak governance practices
and try to analyze corporate governance information. In this situation, their
investment weight is not biased toward any type of information.
To summarize, this paper supports positive links between corporate governance
and financial and non-financial performance of firms by documenting that
governance strength is positively related to the price that individual investors in
Taiwan are willing to pay for stocks. Furthermore, our findings complement and
extend recent governance studies by documenting that governance strength
positively affects individual investors evaluation of companies. These studies find
that governance strength is negatively related to individual investors assessment of
investment risk, positively related to the amount they are willing to invest (Sharma,
2006), and positively related to their credibility perceptions of financial reporting of
firms (Almer et al., 2008). Our findings also reveal that more-experienced individual
investors are better able to incorporate governance strength into their investment
decisions and their credibility perceptions of firm reporting. Moreover, our results
show that when individual investors have both financial information and corporate
governance information to make investment decisions, financial information often
dominates the investment decisions of less-experienced individual investors,
whereas more-experienced individual investors typically put the same investment
weight on both types of information. Consistent with the assertions of the behavioral
finance literature (Nicolosi et al., 2009; Seru et al., 2010) and the literature on
decision-making (Banker et al., 2004; Elliott et al., 2008; Kivetz & Simonson,
2000), our findings show that investment experience enhances the ability of
individual investors to make decisions.
Effects of governance on investment decisions and perceptions of reporting credibility 153

Conclusions

This paper examines the importance of financial information and information on

corporate governance to individual Taiwanese investors enjoying different levels of
investment experience. Consistent with the governance literature, our experimental
results show that individual investors are willing to pay higher prices for the stocks of
firms with strong governance practices and also have higher credibility perceptions of
reporting by those firms. Hence, governance strength positively affects Taiwanese
individual investors decisions. Furthermore, our findings show that more-experienced
individual investors are willing to pay higher prices for the stocks of well-governed firms
and regard those firms reporting as more credible. In contrast, financial information
often dominates investment decisions of less-experienced individual investors.
Consistent with the literature on behavioral finance (Feng & Seasholes, 2005;
Nicolosi et al., 2009; Seru et al., 2010) and judgment and decision-making (Banker et
al., 2004; Elliott et al., 2008; Kivetz & Simonson, 2000), we find that investment
experience helps individual investors use information that demands greater cognitive
efforts to process. Specifically, more-experienced individual investors are better able to
incorporate governance strength into their decisions than less-experienced individual
investors, revealing that corporate governance information has greater utility in
investment decision-making in the case of more-experienced individual investors.
Our research might be usefully extended in several directions. One is to expand and
develop our board-related measures of corporate governance. Specifically, additional
research on how specific governance features influence the evaluation and decision-
making process of individual investors would be useful. Second, it would be interesting
to identify whether individual investors perceptions of firm reporting credibility
mediate the relationship between corporate governance strength and investors decision-
making. Third, it is possible that evaluations of corporate governance strength will vary
with the financial or other professional backgrounds of individual investors. Future
experimental studies might examine this issue. Finally, while we find that governance
strength positively affects individual investors perceptions of firm reporting credibility,
it is unclear whether and how financial regulations can make financial statements more
useful to individual investors given corporate governance practices. Future experimental
studies might explore this issue.

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Ruey-Dang Chang (PhD, Southern Illinois University at Carbondale) is a professor of accounting at

National Chung Hsing University, Taiwan. He received his PhD in Accounting from Southern Illinois
University at Carbondale. His current research interests include auditing, financial reporting, and corporate
government. He has previously published work in Information and Management, Total Quality
Management & Business Excellence, Review of Accounting and Finance, and International Journal of
Accounting Studies.

Jo-Ting Wei is a PhD candidate at the Department of Business Management, National Sun Yat-sen
University, Taiwan. Her current research focuses on corporate governance, earnings quality, and
management accounting. Her dissertation research examines the association among mandatory restate-
ments, family involvement, and replacement decisions for related parties of financial statements. She has
presented and published her research papers and articles at several accounting conferences and journals.